Stephen F. Austin State University
SFA ScholarWorks
Faculty Publications
Forestry
1999
What’s the monetary value of your
premerchantable timber?
Steven H. Bullard
Stephen F. Austin State University, Arthur Temple College of Forestry and Agriculture, [email protected]
Tom Monaghan
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Bullard, Steven H. and Monaghan, Tom, "What’s the monetary value of your premerchantable timber?" (1999). Faculty Publications.
Paper 95.
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Steve Bullard and Tom Monaghan, Mississippi Sta te University
11
Premerchantable" timber
is not yet merchantable-in
most cases this means the
trees are too small to be
sold for pulpwood or other
commercial
products.
Sometimes referred to as
''precommercial"
or
''immature," timber stands
with average tree diameters less than five inches
occupy over 50 million
acres in the South-an area
roughly the size of North
and South Carolina combined .
•
I?emerchantable timber stand rna r
be highly valuable for comm rcial u
in the future, but what is their mon tar
value today? This important que tion
often arises in buying and selling land
that has premerchantable timb r in
making damage estimate , and in all eating value between land and tim.b r
for tax purposes.
f m. n There are two broad typ
tary value-market alue and inv t111ent
value. Market value is th pric f r
which an asset would ell on
1np titive basis, and inve tment alu i th
value of an asset to a parti ular inv t r.
Appraisers use variou m th d t
timate these values. Mark t
lu f ·
example, can be e timat d u in
cost approach-an e timat f th
FOREST LANDOWNER
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of replacing the asset; the income
approach-an estimate of the value
today of the asset's projected income;
and comparable sales-information on
prices paid for similar properties.
Most appraisers prefer to use comparable sales information to estimate
the 'alue of an asset, particularly when
estimating market value. In some cases,
howe\ er, ales information isn't readily
av ailable for p roperties w ith "comparable" ite and stand characteristics.
In this article we describe a few of
the meth ds used to estim ate the value
of premerchantable timber stands. The
m thods estimate investment value,
and they can help in estimating the
market value of premerchantable timber where comparable sales information
. I .~'t·.
·f,
is not available. Note that these methods estimate the value of the premerchantable timber only. To estimate the
total value of a forested tract, land value
should be added to the value of the premerchantable timber.
Traditional Methods
Two traditional methods of estimating premerchantable timber value are:
(1) Comp ounded Costs, and (2)
Discounted Revenues. Because these
methods are often used, forest
landowners should understand their
basic rationale and application. Both of
them ignore some important parts of
premerchantable timber value, howev~r, so they are not recommended for use
m estimating investment value.
Compounded Costs
A common method of estimating
premerchantable stand value is to
"compound" all of the timber's production costs to the stand's current age.
"Compounding" is the process of
accounting for the time value of the
money that has been invested in the
stand. To do this, compound interest
formulas are applied to site preparation,
planting and other costs incurred in
establishing and maintaining the stand.
Example. Consider a pine plantation that was established for $150 I acre
eight years ago, and assume that 7%
interest is the owner's guiding rate of
return. Using the compounded cost
approach, the investment value of the
eight-year old stand is:
$150 x 1.078
= $257.73 I ac.
The compound interest formula
used to calculate the $257.73 is the same
formula used by banks to determine
account value. That is, if the $150 had
earned 7% each year in an interest-bearing account, the account would have
$257.73 after eight years.
Compounded costs are sometimes
referred to as "seller's value," in this
case reasoning that $257.73 is the minimum amount a seller would accept for
the trees if he wanted to earn 7% interest on the site preparation and planting
investment. Others, however, prefer to
call compounded costs "buyer's value,"
reasoning that $257.73 is a relatively
low estimate of value, and thus the
amount a buyer would offer as appropriate using 7% interest.
In this example, note that the
MARCH
I APRIL 1999 •
$257.73 I acre estimated stand value
does not include the value of the land.
The estimated value is for the premerchantable timber only.
In general, the younger the stand,
the more accurate the investment value
estimate will be using compounded
costs. This method, however, typically
yields relatively low estimates of stand
value because it underestimates the
actual costs involved in producing a
stand. The money tied up in land, for
example, is part of a landowner's cost of
producing timber, yet this cost is
ignored in the compounded cost estimate of premerchantable timber value.
Discounted Revenues
Another method of estimating the
investment value of premerchantable
timber is to "discount" the timber's projected (future) revenues to the stand's
current age. "Discounting" is the
process of accounting for the time value
of the money that is expected from the
timber in the future. To do this, compound interest formulas are applied to
the expected timber harvest revenues.
Example. If the pine plantation in
the previous example is expected to be
harvested at age 20 for pulpwood, what
is the value of the stand at age eight to
an investor who would like to earn 7%
interest? If we assume the stand will
yield 45 cords/ acre of timber at age 20,
and if we assume a future price of
$50 I cord, the expected harvest value is
(45 cds./ac.) x ($50/cd.) = $2,250/acre.
Using
the
discounted
revenue
approach, the investment value of the
eight-year old stand is:
$2,250 = $999.03/ ac
1.0712
The formula above simply "discounts" the $2,250 I acre projected revenue for a 12-year period using 7% as
the expected rate of return on the
investment. Why was 12 years used?
Because if the timber is purchased today
(at age eight), revenue from selling timber won't be received for 12 years, when
the stand is 20 years old. This approach
calculates "present value" (value today)
by "discounting" the value expected for
the timber 12 years in the future. Note
that if other harvest options are considered, their discounted value can also be
calculated. The value of the premerchantable timber to a particular investor
would be the highest value he obtains
using his expected rate of return as the
interest rate.
Again, this method uses the same
formula used by banks to calculate
account value-if you placed $999.03 in
a 7% interest - bearing account, after 12
years the account would have $2,250.
Discounted revenues are sometimes
referred to as "buyer's value," reasoning that $999.03/acre is the most a
buyer would be willing to pay for the
trees today if he wanted to earn 7% on
the timber investment, and if
$2,250 I acre in 12 years is a reasonable
expectation of future revenues. Others
use the phrase "seller's value" for discounted revenues, however, because the
estimate is relatively high.
As with the other methods for estimating stand value, note that the
$999.03/acre estimated value is for timber only. Land value would need to be
added to estimate the value of land and
timber together.
In general, the older the stand, the
more accurate the investment value
estimate will be using discounted revenues. As 110ted above, however, the
discounted revenue method often
yields relatively high estimates of the
investment value of premerchantable
timber. Trees grow on land, and the cost
of the money tied up in land is not
accounted for in the above calculation
of discounted revenues.
The ROI Method
The "ROI" method for estimating
premerchantable stand value involves
calculating and using the overall return
on investment (ROI) for the land and
timber combined. This annual interest
rate represents the owner's rate of
return on the money invested in land
and timber during the life of a stand.
The ROI method for estimating premerchantable stand value is more involved
than most forest landowners can calculate "by hand," but computer programs
and other aids are available for those
with further interest in this important
issue. [See the inset box titled "For More
Information."on page 14]
The ROI method has
three steps:
1. Calculate ROI for the land and timber
investment.
ROI is the average annual rate of return
on the investment, considering all costs
and all projected revenues for the stand,
including the value of the underlying
land.
The 11 Time Value" of MoneyAn Important Concept in Estimating. the Monetary Value of Premerchantable Timber
2. Calculate annual "land rent" using the
Premerchantable timber is expected to produce revenue in the future - perhaps in five,
ten, or twenty years- but each dollar of revenue to be received in the future doesn't have
the same "value" a dollar has today. Because a dollar today is not the same as a dollar
tomorrow, money is said to have a "time value"-it has "value" with respect to a specific point in time. To estimate the investment value of premerchantable timber stands, one
must accoLmt for the time value of costs and revenues, .i ncluding those that are expected
in the future. Compound interest is used to accmmt for the time value of money.
This "rent" reflects the annual cost of
using the land to produce a timber
stand.
land value and the calculated ROI.
3. Compound all timber production costs to
the stand's current age, using ROI as the
interest rate.
"Compound" means to use compound
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FOREST LANDOWNER
interest
formulas-formulas
that
account for the time value of money.
The lan d rent calculated in step 2
should be included as an annual cost.
Exam ple. If $1501 acre was invested
in stan d establishment, and a final harvest revenue of $2,250 I acre is projected
at stand age 20, what is the stand's
investment value at age eight using the
ROI method? For this example we'll
assume th e value of the land was
$400 I acre when the stand was established eight years ago, and we'll assume
the lan d value is expected to be
$6001 acre w hen final harvest of the timber occurs.
For this example, the three steps in the
ROI method are:
1. Calculate ROI:
The owner of the timber stand invested
$150 + $400 = $550 I acre
at the beginning of the stand's life (site
preparation an d planting costs plus
land value). When the timber is harvest-
ed at age 20, the total value of the land
and timber asset is expected to be
$2,250 + $600 = $2,850 I acre (timber harvest value plus land value in the
future) .
If you invest $550 and 20 years later
you have an asset worth $2,850, what is
the annual rate of return on your investment? This can be calculated using an
investment calculator, or using a computer program designed to account for
the time value of money.
In this case, the ROI is approximately 8.57% per year. If you invested
$550 at a compound annual interest rate
of 8.57%, after 20 years you would have
about $2,850.
2. Calculate annual land rent:
In this example the value of the land is
projected to increase from $400 I acre
when the stand was established, to
$600 I acre when the final harvest is projected. The land and timber investment
is projected to earn 8.57% per year, so in
the first year· the land cost or "rent" is
$400 x .0857 = $34.28 I acre. This value
increases each year, however, as the
land value increases. In this example,
the land increases in value by about 2%
establishment cost has a compounded
value of $289.581 acre, and the annual
land rent has a compounded value of
$395.961 acre. Adding these amounts
yields a premerchantable timber investment value of $685.541 acre. Again, this
value is for the trees only. The combined
value of land and timber is estimated by
adding the land value to the value of
the premerchantable timber. Current
land value is estimated as $468.66 I acre
(Table 1), so the land and timber together have an investment value of:
$468.66 + $685.54 =
(Land) + (Timber)
$1,154.20 per acre.
S·um,m ary
Many things affect the investment
value of premerchantable timber.
Revenues projected from the future sale
of timber, for example, are affected by
expected prices and estimated yields of
merchantable products.
Traditional methods of estimating
premerchantable timber value may
understate or overstate investment
value because they leave out some
important costs. Table 2 shows the value
estimates for land and timber that
per year, so the land rent increases at a
resulted using these approaches in our
similar rate.
Table 1 shows the estimated land
rent for each of the stand's first eight
years (assuming land value starts at
$400 I acre and increases at 2% per year).
In step 3, each of the land rent values in
Table 1 is carried forward to the stand's
current age using compound interest to
account for the money's time value.
example. The ROI method accounts for
expected costs and revenues from the
timber, and it considers the "time
value" of the money invested in planting and management practices, as well
as the money invested in the underlying
land.
3. Compound all .t irrzber production costs to
tlze stand's current age, usit~g ROl as the
interest rate.
"Compounding" involves using specific compound interest formulas to carry
all costs incurred in establishing and
maintaining the stand forward to the
stand's current age. As stated above,
this includes the annual "rent" calculated in step 2. Using the 8.57% ROI for the
example stand, at age eight the stand's
Tra.b le 2. Example estimates of the
investment value of land and timber
combined.
Considering the "time value" of
Compounded Costs:
$468.66 + $257.73 =$726.39 I acre.
(Land) + (Timber)
Di.scoull:1lted Revenues:
$468.66 + $999.03=$1,467.69 I acre.
(Land)+ (Timber)
ROli:
$468.66 + $685.54=$1,154.20lacre.
(Landi.) + (Timber)
MARCH
I APRIL 1999 •
money involves the use of compound
interest formulas, and the ROI approach
is most easily applied by using a computer program prepared for that purpose. One program that is available to
forest landowners is FORVAL for
Windows. This program was developed
at the Forest and Wildlife Research
Center at Mississippi State University
for evaluating forestry investments in
general. It has a section that applies the
ROI method for estimating the investment value of premerchantable timber.
Forest landowners may find that
their premerchantable timber has a relatively high value. This is particularly
true for pine stands in areas with relatively high prices and good yields. In
most cases, a professional forester
should be consulted in estimating volumes and values of timber stands. In
cases where total tract value is being
estimated (land and timber combined),
forest landowners should be sure to add
the value of their land to the investment
value of premerchantable timber. •
References
The following articles have information
that relates specifically to estimating the
value of premerchantable timber:
Chang, S.J. 1990. Comment II. Forest
Science 36(1):177-179.
Foster, B.B 1986 Evaluating precommercial timber. Forest Farmer 46(2):20,21
Foster, B.B 1986. An alternative
method for evaluating precommercial timber. The Consultant 31(2):29-34.
Kemperer, W.D. 1987. Valuing young
timber scheduled for future harvest.
Appraisal Journal 55(4):535-547.
Straka, T.J. 1991. Valuing stands of
precommercial timber. Real Estate Review
21(2):92-96.
Straka, T.J., and S.H,. Bullard. 1996.
Land expectation value calculation in timberland valuation. Appraisal Journal
64(4):399-405.
Vicary, B.P. 1988. Appraising premerchantable timber. The Consultant 33(3):5659.
Dr. Steve Bullard is a Professor in
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FOREST LANDOWNER
the Department of Forestry
Mississippi State University.
at
Dr. Tom Monaghan is the Leader of
Extension Forestry in the Department
of Forestry at Mississippi State
University.
Approved for publication as article
number FO 106 of the Forest and Wildlife
Research Center at Mississippi State
University.
For More Information
Dr. Steve Bullard of Mississippi State University and Dr. Tom Straka of Clemson
University have written a 270-page workbook titled "Basic Concepts in Forest
Valuation and Investment Analysis." The book has many examples and details of
forestry investment analysis, including the important question of premerchantable
timber value. Computer software titled FORVAL for Windows is distributed with the
workbook by P R E C E D A Education & Training in Auburn, AL
(334-821-9222 • [email protected]). This software includes the ROI approach for
estimating the investment value of premerchantable stands.
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